The consumer price index will either make or break the Treasury market rally, participants said. Prices ended yesterday's session narrowly mixed with the 30-year bond closing unchanged, to yield 5.87%.

The closely watched barometer of retail prices, which is being released this morning, is the next hurdle that the market must clear on its move down to lower yields. * Should the report mirror the producer price index and indicate that inflation is not heating up, debt market participants believe bond yields will get the tailwind they need to reach 5 3/4% in coming sessions.

But a higher-than-expected reading on the consumer price index is likely to land a sobering blow to one of the most impressive bond market rallies in modern history, they said.

"The market needs to get some confirmation of the inflation report last week," said Steven Wood, director of financial market research at Bank of America.

The producer price index fell a surprising 0.6% in August. While the bulk of the decline was related to lower tobacco prices, observers said the numbers supported the market's view that the economy is expanding, but not fast enough to boost inflation or create jobs.

"There are a number of signs telling the market that inflation is not a threat, and that is helping the bond," said James Kenney, head governments trader at Prudential Securities Inc.

The results of a survey of economists conducted by The Bond Buyer showed that market expectations center on increases of 0.2% for the overall report, and 0.2%, excluding food and energy.

William Sullivan, director of financial market research at Dean Witter Reynolds, said that while the market has built in a slight increase in consumer prices, there is the chance that the report could show more modest gains in prices, as did the producer price index.

"I recognized that there is some risk that sharp declines in tobacco prices could be a factor, as they were in the producer price index," he said.

Sullivan predicted that the market would hold its own with an increase of about 0.2%. However, prices are likely to gain further if the figures show larger-than-expected declines, he said.

Market observers hold that other price indicators have painted a weak picture of conditions in the real economy. Activity in the precious metals market have resulted in sharp declines in gold and silver prices. The Commodity Research Bureau's closely watched index of commodity prices has also moved steadily lower in recent sessions.

Bright prospects for inflation continue to attract a steady flow of money into long-dated Treasury issues. With the federal funds rate set at 3% and all indications favoring steady Federal Reserve policy, Kenney said the greatest opportunity for capital appreciation exists at the long end of the curve.

"The short end of the market is not getting a whole lot of sponsorship these days," Prudential's Kenney said.

With no economic indicator reports released and all eyes fixed on today's consumer price index, the market consolidated yesterday.

The intermediate and long sectors of the market continued to benefit from money flowing out of mortgage-backed securities and into Treasuries. The short end lagged as focus remained on the upcoming inflation reports and their effect on longer-dated paper.

Treasury note and bond prices followed movements in precious metals prices yesterday. Most accounts stayed on the sidelines yesterday, not willing to place new bets on the market ahead of the second installment of this week's inflation series.

Declines in gold and silver prices brought a bid to the intermediate and long sectors of the curve and provided participants with the only real impetus to enter the market. Gold fell below $350 per ounce for the first time in four months.

"Buying interest came off the slump in gold prices, which held the market's attention much of the day," said Sullivan of Dean Witter Reynolds.

In auction news yesterday, the Treasury's three-month and six-month bill sales attracted strong demand, averaging rates of 2.98% and 3.06%, respectively. The bid-to-cover ratios were high at 5.34 for the three-month bill and 4.46 for the six month bill.

In futures, the September contract ended down 12/32 to 119.10.

In the cash markets, the two-year note was quoted late yesterday down 2/32 at 100.03-100.04 to yield 3.80%, the 4 3/4% five-year note ended unchanged at 100.10-100. 12 to yield 4.66%, the year note was up 1/32 at 103.19-103.21 to yield 5.27%, and the 6 1/4% 30-year bond was unchanged at 105.07-105.09 to yield 5.87%.

The three-month Treasury bill was unchanged at 2.97%, the six-month bill was unchanged at 3.07%, and the year bill was up one basis point at 3.20%.Treasury Market Yields Prev. Prev. Monday Week Month3-Month Bill 3.01 2.99 3.076-Month Bill 3.14 3.10 3.201-Year Bill 3.30 3.22 3.392-Year Note 3.80 3.69 3.943-Year Note 4.09 3.99 4.345-Year Note 4.66 4.62 5.027-Year Note 4.85 4.87 5.2910-Year Note 5.27 5.29 5.6730-Year Bond 5.87 5.93 6.29Source:Cantor, Fitzgerald/Telerate

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